2. Practices of Irrigation Water Pricing
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\J4S ILI(QQ POLICY RESEARCH WORKING PAPER 1460 Public Disclosure Authorized Efficiency and Equity Pricing of water may affect allocation considerations by Considerations in Pricing users. Efficiency isattainable andAllocating Irrigation wheneverthe pricing method affectsthe demandfor Public Disclosure Authorized Water irrigation water. The extent to which water pricing methods can affect income Yacov Tsur redistributionis limited.To Ariel Dinar affect incomeinequality, a water pricing method must include certain forms of water quantity restrictions. Public Disclosure Authorized Public Disclosure Authorized The WorldBank Agricultureand Natural ResourcesDepartment Agricultural Policies Division May 1995 POLICYRESEARCH WORKING PAPER 1460 Summary findings Economic efficiency has to do with how much wealth a inefficient allocation. But they are usually easier to given resource base can generate. Equity has to do with implement and administer and require less information. how that wealth is to be distributed in society. Economic The extent to which water pricing methods can effect efficiency gets far more attention, in part because equity income redistribution is limited, the authors conclude. considerations involve value judgments that vary from Disparities in farm income are mainly the result of person to person. factors such as farm size and location and soil quality, Tsur and Dinar examine both the efficiency and the but not water (or other input) prices. Pricing schemes equity of different methods of pricing irrigation water. that do not involve quantity quotas cannot be used in After describing water pricing practices in a number of policies aimed at affecting income inequality. countries, they evaluate their efficiency and equity. The results somewhat support the view that water In general they find that water use is most efficient prices should not be used to effect income redistribution when pricing affects the demand for water. The because water prices are a poor vehicle for reducing volumetric, output, input, tiered, and two-part tariff income inequality. But pricing schemes that involve schemes all satisfy this condition and can be efficient, water quota rules can reduce income inequality. The although whether efficiency is short-run or long-run, authors demonstrate this with a two-rate tiered pricing first- or second-best, varies. scheme combined with equal quotas of the cheaper Pricing schemes that do not directly influence water water. input - per-unit area fees, for example - lead to This paper - a product of the Agricultural Policies Division, Agriculture and Natural Resources Department - is part of a larger effort in the department to implement the World Bank water resources management policy. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Cicely Spooner, room N8-039, extension 32116 (40 pages). May 1995. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues.An objective of the seriesis to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should he used and cited accordingly. The findings, interpretations, and conclusions are the authors' own and should not be attributed to the World Bank, its Executive Board of Directors, or any of its member countries. Produced by the Policy Research Dissemination Center Efficiency and Equity Considerations in Pricing and Allocating Irrigation Water Yacov Tsur The Hebrew University of Jerusalem and The University of Minnesota and Ariel Dinar The World Bank 1. EXECUTIVESUMMARY 1 2. PRACTICESOF IRRIGATIONWATER PRICING 3 2.1. Costs of delivery and methods of charge 3 2.2. Pricing practices in developing countries 4 2.3. Pricing practices in developed countries 8 3. EFFICIENCYPERFORMANCE OF PRICINGMETHODS 12 3.1. Efficiency concepts 12 3.2. General setup . 12 3.3. Volumetric pricing 15 3.4. Output and input pricing 16 3.5. Per area pricing 18 3.6. Additional pricing methods 19 3.7. Summary of the efficiency analysis 20 4. EQUITY MEASURES 22 4.1. Descriptive measures of income inequality 22 4.2. Normative measures of income inequality 25 5. EQUITY PERFORMANCEOF SOME WATER PRICINGMETHODS 27 5.1. Volumetric pricing 27 5.2. Per unit area pricing 27 5.3. Output pricing 28 5.4. Tiered pricing 28 5.5. Summary of the equity analysis 29 6. NUMERICALEXAMPLE 30 7. CONCLUSIONS 34 ii APPENDIX: A NORMATIVEINTERPRETATION OF DESCRIPTIVEINEQUALITY MEASURES 35 REFERENCES 37 1. ExecutiveSummary The notion of economic efficiency is concerned with the totality of wealth that can be generated by a given resource base. Equity concepts, on the other hand, deal with how the total wealth is to be distributed among the society's members. The former receives much more attention, as concept of Pareto Efficiencv (i.e., an allocation from which it is impossible to depart without making one or more individuals worse off) captures center stage in Neo-Classical Economics. One reason, perhaps, is that distributional aspects entail interpersonal comparisons which are inherently subjective (i.e., involve value judgment which varies from person to person depending on cultural, traditional and other personal variations). In this work we investigate efficiency and equity performance of various irrigation water pricing methods. We begin, in the next section, with a summary of water pricing practices as applied in a number of countries. Section 3 defines efficiencv concepts in the context of water pricing and evaluates the performance of the different pricing methods in this regard. Section 4 discusses descriptive and normative income inequality measures. Effects on income inequality of the different pricing methods are identified in Section 5. Section 6 concludes with a numerical example. In general, efficiency of water use is attainable whenever the pricing method affects the demand for irrigation water. The volumetric, output, input tiered and two-part tariff schemes all satisfy this condition and can achieve efficiency, though the type of efficiency (short or long run, first or second best) vary from one method to the other. These methods also differ in how they are implemented and the amount and type of information needed in their implementation. Pricing schemes that do not influence water input directlv, such as per unit area fee, lead to inefficient allocation. Such methods, however, are in general easier to implement and administer and they require a modest amount of information. Concerning equity perfornance, our (unfortunate) conclusion is that the extent to which water pricing methods can affect income redistribution is rather limited. Farm income disparities are due mainly to such factors as farm size and location, and soil quality, but not to water (or other input) prices. We find that when farmers are per-hectare identical in production (i.e., vary only with farm size), face the same prices, and no quantity quotas are applied, the income distribution profile under most water pricing methods is proportional to the initial farm size distribution profile. Since measures of income inequality (with the exception of the variance) are not sensitive to proportional shifts in income. inequality is due solely to the farm size inequality and is independent of the pricing method or water rates used. Pricing schemes that do not involve quantity quotas cannot be used in policies aimed at affecting income inequality. This includes the volumetric, output, input, tiered, and 2 per-hectare pricing methods, among others. To affect income inequality, a water pricing method should include certain forms of water quantity restrictions. These results lend some support to the view that income redistribution policies should not be carried out via water prices (see, e.g., Seagraves and Easter, 1983); not because it involves wrong doing but because water prices serve as a poor means to reduce income inequality. However, pricing schemes that involve water quota rules can reduce income inequality. We demonstrate this with a two rate tiered pricing scheme combined with equal quotas of the cheaper water. Acknowledgment Comments from K. William Easter, Eitan Hochman, Herve Plusquellec, James Roumasset, and David Steeds are gratefully acknowledged. Data collection on pricing practices by R M Chellappan is acknowledged. 3 2. Practicesof IrrigationWater Pricing 2.1. Costs of delivery and methods of charge Costs of irrigation water supply consist of variable costs of processing and delivering the water to end users and of fixed cost of capital operation and maintenance (O&M). Variable costs depend on the amount of water delivered, while fixed costs do not. In most countries, fixed costs are heavily subsidized (UN, 1980). The method by which irrigation water is delivered affects the variable cost, as well as the irrigation technology applied and the feasible pricing schemes. Water may flow continuously or in certain time periods (in which case it may or may not be delivered upon demand); the conveyance system may consist of open channels or closed pipes. Often, the irrigation water in a region is delivered by more than one method, depending on tradition, physical conditions, and water facilities and institutions (UN, 1980). Existing water pricing methods include (Rhodes and Sampath, 1988; Sampath, 1992): Volumetric: Water is charged based on direct measurement of volume of water consumed. Variation of the volumetric approach include (1) indirect calculation based on measurement of minutes of known flow (as from a reservoir) or minutes of uncertain flow (proportions of a flow of a river), and (2) a charge for a given minimal volume to be paid for even if not consumed. Output: Irrigation water is charged on per output basis (irrigators pay a certain water fee for each unit of output they produce). Input: Water is charged by taxing inputs (irrigators pay a water fee for each unit of a certain input used). Per unit area: Water is charged per irrigated area, depending on the kind and extent of crop irrigated, irrigation method, the season of the year, etc.